After another 80% or so plunge from its high in 2021 to its low in 2022, Bitcoin has rebounded again to a new record high. The next chart shows Bitcoin’s price relative to the $US since 2010, both on a regular scale and on a log scale to show perspective. From its 2022 low it’s up more than fourfold. This is naturally sparking a new round of questions as to “what’s driving it”? and “should we invest in it”? The answer not simple. Bitcoin attracts extreme views - evangelists on the one hand and agnostics and atheists on the other in contrast to other things where the debate is between bulls and bears. This note looks at what it means for investors.
Bitcoin basics
Bitcoin was invented in 2008 by a person or group named Satoshi Nakamoto and the first “genesis block” was created in 2009. Trying to explain it and cryptocurrencies generally (and the blockchain technology that underpins them) is very complicated! The blockchain basically means that transactions in Bitcoin are verified and recorded in a public ledger (the blockchain) by a network of nodes (or databases) on the internet.
New Bitcoins are created as a reward for an intensive computational record keeping process called mining, that groups new transactions into a block which is added to the chain. This requires significant computing power to show what is called “proof of work”. The supply of Bitcoins is limited to 21 million, but because of a process called “halving” which occurs roughly every four years and sees miners compensated by less Bitcoins over time the limit will only be reached around 2140 after which transactions fees will be the only reward for record keeping. Because each node stores its own copy, there is no need for a trusted central authority like a central bank. Bitcoin is also anonymous with funds tied to Bitcoin addresses which require a private key (a long password) to access.
Because of Bitcoin’s limited supply and independence from government it’s seen as a hedge against the debasement of paper currencies (through inflation), the failure of central banks or outright seizure. This has made it attractive to supporters of the Austrian school of economics (which advocates a free market in money), libertarians and anarchists.
As with most technologies, the more that use it the greater its appeal. So news that various groups will accept transactions in it, El Salvador’s 2021 move to allow it as legal tender and various financial organisations allowing customer access via their platforms have aided its growth. The recent approval of Bitcoin ETFs and regulation of it, along with a coming halving (around April) have helped propel the recent surge in its price.
The number of cryptocurrencies blew out to more than 10,000 at the end 2023. Some started as jokes (eg, Dogecoin); some prioritise underpinning smart contracts (like Ethereum); some prioritise transactions (stablecoins that link to the value of a paper currency, eg, Tether); whereas others prioritise being a store of value independent of government (eg, Bitcoin).
Of course, there is a lot of overlap. The focus for most remains on Bitcoin which is the oldest and biggest with a near 50% crypto market share.
Reasons for scepticism
Bitcoin enthusiasts see it as the future currency and as a way to riches with rapid price gains since inception seen as confirmation. The counter view is that it’s just another bubble. Reasons for caution are as follows:
• First, it’s not suitable for everyday transactions: Bitcoin transactions are not cheap costing $US9 at present; they can take 8 minutes or so to complete; its price is very volatile (being roughly 13 times greater than US shares, 12 times greater than gold, 26 times greater than the $US and 17 times greater than the $A/$US exchange rate) suffering 80% plunges in price every few years (in 2011, 2013-15, 2017-18 and 2021-22) rendering it unreliable as a short term store of value. Its limited value for use as a means of payment explains why most Bitcoin transactions are by speculators, not merchants. This is not to say Bitcoin may not have a role in some countries – eg, El Salvador – where the government is not trusted and much of the population lives in the US and faces high transaction costs sending money home. But even in El Salvador merchants have not rushed into using Bitcoin and the US, Europe & Australia are not banana republics!
• Second, there may be a role for cryptocurrency in payments systems (either stablecoins or Ethereum that have moved to speed up their processing), but who knows which one it will be and governments are likely to want to provide it themselves. But even here work on Central Bank Digital Currencies has slowed as its not clear people want to use them as we can already do digital transactions instantly & cheaply.